CalPERS Chief Investment Officer announced his resignation at the start of Monday’s Investment Committee meeting. From CEO Marcie Frost’s statement:
From: “Frost, Marcie”
Date: 5/14/18 9:32 AM (GMT-08:00)
Subject: Personnel Update
Good morning CalPERS Team,
I wanted to let you know that Ted Eliopoulos, our Chief Investment Officer, has shared with us that he will be leaving CalPERS to move to the East Coast, where his two daughters attend college. He will be with us through the remainder of this year as we search for a new CIO and help that individual transition into the role. Ted is committed to a smooth transition to minimize any disruption to CalPERS as he hands over the INVO leadership to a new CIO.
Ted joined us in 2007 from the State Treasurer’s Office. During this time, he has been instrumental in a number of important accomplishments, including greatly reducing the number of external managers and increasing the amount of assets managed by CalPERS’ own investment professionals. Ted’s commitment to reducing cost and complexity will benefit our members and fund long into the future.
Ted has been a thoughtful and calm presence at CalPERS, willing to listen to diverse points of view and explore creative solutions to the challenges we face. Under his leadership, we ended our hedge fund program and began examining new business models for private equity that could add significant value to the CalPERS fund. Ted also established the Investment Office’s first Diversity & Inclusion Committee, and last year he played a key role in establishing a mentoring partnership with the mayor of Sacramento that enabled several area high school students to spend the summer working and learning in the Investment Office. If you know Ted, you’ll know how important mentors were in his own life and why being a role model for young people means so much to him.
I am thankful that we will have him here to assist with a seamless transition to new leadership in the Investment Office over the next few months. On behalf of all of CalPERS, I want to wish Ted much success in the future and thank him for all he’s done on behalf of California’s public employees.
Quite honestly, I was shocked to read this missive. As much as we have been critical of Eliopoulos, regarding him as a generally capable individual who wound up in a role for which he was not qualified, when the investment environment bloodied many top professionals, this was damning with too obviously faint praise. The fact that she brings up Eliopoulos mentoring several high school students for one summer in a mere two paragraphs on his accomplishments is a slap in the face. It is if she were struggling to find something positive to say about his over-ten-year record in top level roles. Frost should be ashamed of herself.
By contrast, the Wall Street Journal has a far more comprehensive list of Eliopoulos’s accomplishments, as well as some of his less successful initiatives.
The great irony is that Eliopoulus would have been a capable CEO of CalPERS, yet from what I can infer, he never tried to put his hat in that ring when CEO and close ally Anne Stausboll retired in 2016. The CEO is a political and administrative position, and that would have been a much better fit with Eliopoulos’ skills. Former board member JJ Jelincic said that Eliopoulos was not qualified to be Chief Investment Officer, which was obviously true given Eliopoulos’ credentials and experienced. The board censured Jelnicic for his observation, and time has now shown Jelincic to have been correct.
In an era of higher prevailing returns, Eliopoulos would not have been tested to the degree he was. The conundrum for investors all over the world, and it was most acute for long term investors like pension funds, was that central banks all over the world were punishing savers via negative, sometimes deeply negative, real interest rates. That meant investors were chasing for yield and bidding the prices of risky assets up to the degree that they were underperforming relative to their downside potential.
CalPERS decision at the end of 2014, to exit hedge funds, which Frost deigns to mention only in passing, sent shock waves through the investment world, since it legitimated what other major investors should have done long ago: questioning whether these high-fee, exotic strategies delivered their promised performance. By early 2016, further deterioration in the hedge fund performance led to large scale redemptions across the industry.
However, Eliopoulos was unwilling or unable to take the same logic that led him to question correctly question hedge funds to its logical conclusion with an investment strategy that has wound up damaging CalPERS as well as Eliopoulos: private equity. Recall that the pay to play scandal that led to former CEO Fred Buenrostro to be sentenced to four and one-half years in Federal prison for taking bribes implicated three other then-current board members. Yet the firm that paid far and away the biggest bribes, erm, fees, nearly $50 million dollars to former board member, later placement agent Al Villalobos, wasn’t even made to sit in the penalty box, as is the norm for defense contractors.
CalPERS, like most of its public pension fund peers, pinned undue hopes on private equity, even though as time went on, the data kept confirming that private equity from the early 2000s onward was failing to meet its benchmarks. Eliopoulos had the misfortune of inheriting a head of private equity, Real Desrochers, who on paper had a solid background, but proved in some embarrassing exchanges with Jelnicic in open sessions not to understand some basics of private equity investing. Desrochers also had a reputation for being difficult which some market participants see as having contributed to some of CalPERS’ alleged difficulties.
CalPERS got itself in further hot water in private equity due to staff acting as if they could blow off reasonable, even basic questions, and take the position that they knew better when they didn’t. That backfired dramatically in 2015. Former Chief Operating Investment Officer Wylie Tollette tried brushing off questions by Jelincic by not only admitting that CalPERS didn’t track carry fees, one of the largest charges CalPERS pays to private equity firms, but that no one could. This led to an explosion of negative press coverage, forcing CalPERS to retreat and gather the data.
To try to shore up its image and reassure the board, CalPERS then held a full day private equity workshop in November 2015. That didn’t go so well either, as we explained in a series of posts.
Eliopoulos did have the right intuition, of trying to lower private equity fees and costs. It is too bad that he didn’t follow it to its logical conclusion, of abandoning private equity entirely, doing private equity replication in public markets (which would probably have a run of a few years until other investors piled in, but that would have bought CalPERS time to strengthen internal capabilities), or of doing much more in house to cut out the costly middlemen. A study published in early May found that public pension funds with higher allocations to “alternative” investments did worse than ones who were more cautious (to CalPERS’ credit, it has only a moderate commitment to these strategies). From our post summarizing the results:
The latest report from the Maryland Public Policy Institute is short and succeeds at clear and to the point. It is also damning. Its implications are clear: public pension funds all over the US would do better to fire their investment staffs and hand management over to Vanguard, using a simple mix of 60% stocks, 40% bonds.
Moreover, the magnitude of the shortfall relative to the bog standard allocation for long-term retail investors is large. A 60/40 portfolio earned an average annualized return of 6.40% for the ten years ending June 30, 2017. That happens to be a full 2% more than what CalPERS earned on average over this period. To determine the impact more precisely, you’d need to look at the differences in performance on a year by year basis. However, if you simply take CalPERS total assets at the end of fiscal year 2007, which from what I can infer was $254 billion (remarkably, the 2007 CAFR does not seem to be on line any more), and compound a simple 2% forward, you get an extra $55.6 billion. If you added this to its calendar year end 2017 total assets of $350 billion, you’d have $405.6 billion, which would put it an 82.3% funding level versus its 71% mark at year end.
Eliopoulos took on private equity’s high costs, but in an unduly cautious way, by reducing the number of funds CalPERS invested in, which meant CalPERS was participating heavily in large to mega “buyout” funds. On the one hand, big commitments per fund meant CalPERS got the lowest fees (bigger funds have tiered pricing, with the biggest investors receiving what amounts to fee volume discounts). But buyout funds underperformed private equity as a whole, dragging down performance. Oddly, CalPERS was reportedly a laggard in another approach for reducing cost, namely, co-investing, which is committing additional capital to a particular company along side the general partner, cutting out the management and often the carry fee.
In addition, Eliopoulos and Stausboll, who had been proteges of former state Treasurer Phil Angelides, made the mistake of not adapting to the new normal of central bank super low policy rates and adjusting CalPERS return assumptions downward soon enough. Even though municipalities are now howling over increased pension charges and expected future increases, taking the bitter medicine years earlier would have meant less pain overall. As a stakeholder survey, to be presented at tomorrow’s Finance and Administration Committee, shows, CalPERS image has fallen sharply with senior managers at municipalities and agencies that have CalPES manage their pension plan:
Even though this is only one “stakeholder” group, it is disproportionately influential. First, the leadership ranks make their views known and some, perhaps most, employees will take heed. Second, the in-state press finds these officials a good source of quotes, so having their worries about pension safety bruited about is something CalPERS really would rather not have happen.
Another indicator of the cost of the failure to reduce return assumption sooner is that CalPERS is getting more and more critical press coverage. The media is no longer anywhere as willing as it once was to give the giant pension fund the benefit of the doubt when even with an unexpected Trump runup in stock prices, CalPERS is still only 71% funded.
The problem with Ted’s exodus is that CalPERS now has way too few supervising adults in its investment office. Even if Ted were to apply himself fully to CalPERS during his remaining time in office, lame ducks have limited sway and often need to make only interim decisions so as not to tie the hands of their successor. CalPERS does have a highly qualified new Chief Operating Investment Officer, Elisabeth Bourqui, who was scheduled to start May 14 but she is not yet in place due to visa issues. CalPERS has not hired a new head of private equity, apparently due to Eliopoulos’ determination to push his private equity outsourcing scheme through (more on that in future posts). CAlPERS’ head of fixed income, Curt Ishii, who has long had an industry-leading performance record, retires in July.
Turnoever is usually a negative for the performance of investment firms. But CalPERS needs to make changes If it can attract more professionals of Bourqui’s caliber, the fund may finally make a break from its post Fred-Buenrostro misguided priorities and focus on the needs of the beneficiaries as opposed to the needs of staff.
‘even with an unexpected Trump runup in stock prices, CalPERS is still only 71% funded’
In the survey results, the lowest confidence (48%) is in response to the question, “Are you confident that your retirement money is safe?”
And for good reason: the cited 71% funding is based on a wholly unrealistic assumed return of 7.375% this fiscal year, which inches down to 7.25% next year.
Meanwhile, the 10-year Treasury yields 3.01%, while the S&P 500 offers a dividend yield of 1.91%. With the S&P 500 valued at a top-decile Shiller CAPE of 32 in this late-cycle economy, achieving an annualized return above seven percent for the next decade is not even remotely possible. Everybody knows that a seven percent return is a buck naked emperor, even as we praise his lavish robes and accoutrements.
At a more realistic discount rate of 2.68% (BofAML U0A0 muni bond index), CalPERS’ funded ratio would be well under 50 percent. Which is why a majority of survey respondents are entirely justified in suspecting a material risk of default in the next decade.
After a couple of decades of “just making up” discount rates (which results in inadequate invested principal), the deferred bill eventually comes due in a most shocking way. A recession in 2020 would send CalPERS into an irrecoverable CFT (controlled flight into terrain).
I’ve gotta say that’s a pretty cheesy letter (though maybe I’m reacting badly to “CalPERS Team” in the salutation; perhaps this is standard verbiage in California)*.
The whole thing seems a little perfunctory, even before the descent into bathos with mentoring “several area high school students.” Then you get “if you know Ted” presumably, “like I know Ted,” after a few months on the job. Really?
“Several area high school students.” Several. Two, six, ten, a couple dozen? No numbers at all. It’s amazing that Frost couldn’t trouble herself to get her staff to put together some numbers on Eliopoulos’s tenure; surely ending the hedge fund project had measurable and beneficial consequences financially? Ditto reducing cost and complexity. By how much? In any case, in the context of a valediction, surely gilding the lily a little would be permissible, if needed? But no. We get a series of vague gestures.
I also like using “transition” as a verb and then as a noun in adjacent sentences. Delightfully breezy!
NOTE * Also business letters use a colon, not a comma, in the salutation.
While we’re critiquing, Yves’s typo-neologism-Freudian-slip “hoever” seems quite apropos.
Not trying to find excuses for Ted, but generally speaking I think sometimes, especially when found in such political roles in large, inflexible institutions still basking in the warm light of past glory, leaders find it very difficult to implement the right decisions.
Just because someone has a title does not mean anything (necessarily), unless that person has a proven “power basis” which allows him/her to sway the other senior staff in their favour.
To me Ted seems more like the most visible element of what is going on there, or at least the “punch bag”; maybe this is also why he resigned: he decided he did not want to take another one for the team. I think there are many others in less visible roles who might have some explaining to do. And just because they have suddenly hired someone of high calibre does not mean anything yet.
Of course, I sit in Europe and I am far away from California, but these are my two pennies.
Just so you know, CalPERS is not all that large staff wise. A bit over 3,000 people, the overwhelming majority of which are in various operational roles. since CalPERS both manages a huge amount of beneficiary payments and related servicing, but also runs its own health insurance plan, including a long-term care plan.
My numbers are a bit dated, but in terms of professional staff, there are about only 300 people in the investment office and C level operations. And I believe that includes the actuaries.
Really interesting piece on the new CIO. ABB’s asset allocation methodology is pretty complex.
My crystal ball says an Ortec office is in Sacramento’s future.
But CalPERS needs to make changes If it can attract more professionals of Bourqui’s caliber, the fund may finally make a break from its post Fred-Buenrostro misguided priorities and focus on the needs of the beneficiaries as opposed to the needs of staff.
There’s a similar loss of oversight and transparency in handing pension investments over to PE and in privatizing medicaid. In the case of PE, loss of oversight, accountability, and much higher costs and therefore lower returns in general than had been advertised. I hope a new CIO will tackle this problem. However, as long as Frost is there managing staff, boosting PE, and doing end runs around the board (didn’t she order Margaret Brown locked out?) I have doubts how much a new CIO can change the culture. One can hope. One step at a time.
Thanks for your continued reporting on CalPERS
The fix is in, i reckon Teddy will be joining one of calpers funded GPs in NYC presumably Blackrock. Stay tuned-
“…public pension funds all over the US would do better to fire their investment staffs and hand management over to Vanguard, using a simple mix of 60% stocks, 40% bonds.”
Yes they would! The State of Nevada has about 95% of its pension investments in index funds: https://www.nvpers.org/public/publications/FY17CAFR.pdf
See page 70